Ashok Leyland’s New Heights

Ashok Leyland (AL), headquartered in Chennai, is the second largest commercial vehicle manufacturer in India in the medium and heavy commercial vehicle (M&HCV) segment with significant presence in bus segment. The Hinduja Group holds 51 percent stake in the company through the holding company, Hinduja Automotive (UK). The company has 6 manufacturing plants across 5 locations in India — Ennore (Tamil Nadu), Hosur (Tamil Nadu), Alwar (Rajasthan), Bhandara (Maharashtra) and Pantnagar (Uttaranchal).

The company has been a key beneficiary of sharp recovery in higher tonnage segment, has stronghold of southern region and commendably improved its balance sheet with better free cash flows (FCF) and lower debt. The market share gains are expected to sustain led by expanding product portfolio in small and intermediate commercial vehicle segment and expansion of dealership network across non‐South regions. Sharpening focus on high margin‐businesses like spares, defence and exports is a potent margin trigger. Additionally, sharp recovery in demand over expected period of 2016‐19 will aid further margins.

Increased Market Share in M&HCV

The Chennai-based manufacturer has set new momentum by achieving remarkable 15-year high market share gains in the M&HCV segment. Ashok Leyland has posted 7.7 percent gain from 26.2 percent to 33.8 percent in 4 years.

AL has also emerged as a credible challenger in the commercial vehicle (CV) area by leaving Tata Motor’s (TTMT) behind. Its return on capital employed (RoCE) is 25 percent over TTMT’s ‐1.9 percent in fiscal 2017. During the year, AL’s margins are also significantly high at 11 percent than those of TTMT’s at 2.8 percent. The manufacturer has rule out unhealthy competition in the CV segment and paves the way for continued market share gains and sustains its improving brand equity.

New products and deepening reach: Market share gain catalysts

Ashok Leyland has been plugging the gaps in its product portfolio as well as sprucing up its distribution reach in the past 5 years. It has got strong response to its new launches Sunshine school bus and Guru, the latest Intermediate Commercial Vehicle

De‐risking to prop margins

Ashok Leyland has made deliberate efforts to de-risk business model with focus on exports, defence and spares. This strategic shift is to focus on garnering high margins in non-cyclical business. This calculated step of reducing share of cyclical M&HCV business is a potent margin trigger.

To gain traction in margins for the non-cyclical business, AL has widened its technical capabilities in defence, scaled in spares business and has come with focused exports strategy. In defence, AL has broadened its products supply to 6x6, 8x8 and 10x10 from traditional 4x4 offerings.

The manufacturer’s exports strategy involves increasing its local presence, enter into specific product segments and price its products closer to Japanese peers which will improve chances of success.

At current market price of Rs 105, AL trades at 15.6 times its earnings of 2019. Edelweiss estimates AL’s earning per share (EPS) CAGR as 24.4 percent and an increase of 5.2 percent in return on equity (RoE) at 26.4 percent over 2017‐19.

The business momentum and AL’s focus on profitability should drive already industry leading margins, RoE and stock performance.

KeyRisks faced by Ashok Leyland

SuccessofEGR technology: Ashok Leyland has adopted the new innvoative Exhaust Gas Recirculation (EGR) technology system to comply with BSIV emission norms. Although, globally EGR is used for vehicles up to 180 horsepower (HP) and for Selective Catalytic Reduction (SCR) technology; AL has decided to use EGR for its entire range comprising of up to more than 400HP trucks. Given that this technology is one of its kinds, it is a double edge sword for Ashok Leyland. In case, the technology is successful, it will enable the company to gain significant market share or else, there will be sharp pressure on cash flows and profitability.

Exports and Defence: The development on exports and defence fronts are keenly tracked by the markets. For AL to sustain its valuation re-rating of the stock success in these areas are critical.